module 7 Flashcards
CVP analysis
CVP analysis
concerned with the change in profits in response to changes in sales volumes, costs and prices
when will fixed costs PER UNIT decrease?
when the number of units produced increases
variable costs
Costs vary relative to the change in volume that is involved
VC per unit is…
constant
total VC decreases when…
volume decreases (direct relationship)
which costs stay constant?
total fixed costs
VC per unit
selling price per unit
relevant range
range of activity over which the cost behaviour is assumed to be valid.
mixed costs
have both fixed + variable cost components
what happens when activity is outside the relevant range?
expected behaviour costs will change
–> entity may be going through negotiations about contracts, or changing the level of resources required to support operating activities
2 assumptions about mixed costs
- That they can be separated into their fixed and variable portions.
- That those portions, when separated, are linear (like fixed and variable cost behaviour) within the relevant range of sales volume.
equation for total cost
FC + VC(x)
x = sales volume
high-low method for calculating VARIABLE costs per unit of activity (volume)
calculate the slope (y2-y1/x2-x1)
point 1: highest cost + activity
point 2: lowest cost + activity
broken down version of TC = FC + VC(x)
Total cost (at highest volume level
CVP assumptions
- The behaviour of costs can be neatly classified as fixed or variable.
- Cost behaviour is linear.
- Fixed costs remain ‘fixed’ over the time period and/or a given range of activity.
- Unit price and cost data remain constant over the time period and relevant range.
how can CVP data assist in decision making? (3 things)
- Identifying the number of products or services required to be sold to meet break-even or profit targets.
- Determining the impact on profit of changes in the mix of fixed and variable costs.
- Pricing products.
CM equation
revenue - VC
CM per unit
sales price - VC per unit
Why is CM called contribution margin?
because whatever is left from (revenue - VC) is what is CONTRIBUTING to covering FC
pre-tax target profit equation
SP(x) – VC – FC = estimated profit
x = sales volume
OR
CM per unit - FC
how many sales units to meet targeted profit equation
Target Profit + FC
CM per unit
Break-even equation
when total revenue = total costs
total revenue = FC + VC
break even point equation
* how many sales units to break even?
FC/CM per unit
CM ratio where revenue EXCEEDS VC
Contribution margin per unit /Selling price per unit * 100 = x%
CM ratio expressed as a percentage of revenue
Total Contribution margin/Total Sales * 100 = x%
CM ratio%
100% - VC%
Breakeven point using CM ratio%
FC/CM%
operating profit
revenue * CM ratio - FC
operating risk
- the exposure a company faces from sales being lower than expected.
- It is a function of fixed costs and contribution margin.
- higher the FC relative to VC, the higher the risk
margin of safety
- assesses operating risk
- compares the actual or planned sales level with the breakeven point.
equation for margin of safety
expected (actual) volume - breakeven volume/expected (actual volume)
* 100
operating leverage
the mix between fixed and variable cost in the cost structure of an entity.
- It provides an understanding of the impact of changes in sales on profit.
evaluating risks in operating leverage
- higher the leverage = higher the risk
- fluctuations in sales = higher fluctuations in profit = more risky
additional CM earned
additional sales (CM per unit)
additional profit earned
additional CM earned - additional FC
sales units required equation
sales required = total FC + Profit / CM per unit
